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Every Business Owner Needs a Succession Plan

By Kevin Spafford, CFP®
Founder - Legacy by Design, LLC

Like most people, business owners usually are concerned about their own financial security, providing for their loved ones, and their family’s happiness. However, closely held business or farm owners often have the additional concern of keeping the operation successful after they are no longer running it, since they (or their family members) often depend on it to provide continuing financial security. Even if the owner and family are not financially tied to the business after transferring ownership, the owner may have personal reasons for wanting the operation to continue to succeed.

A sound succession plan addresses the goals that business owners have for themselves and their family. It also can enhance the value of the business by making it less dependent on the talents of the owner. This allows the owner to transfer ownership in the business without its declining in value as a result of the transfer.

Financial Security

Some business owners anticipate and plan for their retirement. Others cannot envision life away from the business and have no intention of ever retiring. Even those who have no intention of retiring must realistically acknowledge that circumstances beyond their control may force them to stop working at some point. An exit strategy ensures that the owner and his family will be able to withdraw adequate financial resources from the business at the owner’s retirement, whether voluntary or not.

The amount of financial resources available to the owner (or his family) when the owner is no longer working will be limited by the business’ value. Planning for ownership and management succession actually enhances value because planning minimizes potentially costly disruptions and disagreements that can take place when the transition happens without additional preparation.

Providing for Dependants

Most owners are concerned about providing financial security for their spouse and children during their life and after their death. A closely held business often represents the owner’s most significant asset. Planning for the transfer of ownership and management control can ensure that the value of the asset is preserved for the owner’s dependants.

Planning for management succession can significantly enhance the business’ value and maximize the wealth transferred to the owner’s dependants. Without planning, it is very likely that the value of the business will decline because the management successor is inexperienced, unprepared, or not well received by key employees, customers, suppliers, or other important third parties. And, a sound succession plan minimizes the estate tax on the business and provides liquidity to the owner’s estate. In addition, the succession plan can be structured to minimize income taxes on business income or the eventual sale of the business. Both measures preserve cash resources and enhance the financial security for the owner’s dependants.

Ensuring the Business’ Continued Success

A closely held business is usually more than just a way for the owner to make a living. A business often gives the owner clout and prestige in the community. It can also represent the owner’s legacy to his children, both financially and in terms of family identity. In addition, many owners have strong loyalties to employees and customers with whom they have worked for many years. So, ensuring the business’ continued success is often a very high priority for the owner.

Planning for management succession ensures that the owner’s death or retirement will not disrupt business operations, as the management successor is prepared to step in immediately and make business decisions. Also, sound planning for management succession includes introducing the potential management successor to key third parties such as customers, suppliers, and bankers. This enhances those parties’ confidence in the management successor and allows him to carry on “business as usual” rather than having to prove himself.

Having a buy/sell agreement is another important way of ensuring that an owner’s departure does not adversely affect the business. Without an agreement in place, the departing owner may transfer his interest to someone who is not qualified to replace him. Giving an inexperienced or unqualified individual a significant ownership stake can cause serious business disruptions. Likewise, a buy/sell agreement typically sets a price, or establishes a valuation method, for which the departing owner’s interest is to be purchased. This can avoid the remaining owners having to spend a great deal of time and energy negotiating with the selling owner, or his estate.

Finally, a sound succession plan balances the needs of the business with those of the owner, which helps ensure that the business is not adversely affected by actions designed to benefit the owner. For example, plans for the owner to withdraw cash after retirement are evaluated not only by whether those payments satisfy the owner’s liquidity needs, but also by their impact on future business operations. This helps ensure the business’ continued viability after the owner’s departure.

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